Secrecy Jurisdictions
Guttorm Schjelderup 1
Norwegian School of Economics and Business Administration and CESifo
This version August 4, 2011
Abstract
The economic literature on tax havens views them as places that offer
opportunities for tax evasion and legal tax planning to individuals and
businesses. In this paper I argue that the economic literature has neglected some
of the most important effects of tax haven legislation. I show that tax havens
provide opportunities to evade national and international regulation in a wide
range of areas of importance to the global economy. They also lower the costs of
all sorts of criminal activity and, in doing so, export illegal actions to other
countries. In some cases, this leads to the violation of basic human rights and
even murder. I also argue that the economic literature has overlooked the effects
tax havens have on poor countries and that these effects are a real obstacle to
economic development.
Keywords: Tax havens and financial offshore centers
JEL classification: H25, F23
1 [email protected]. Financial support from the Research Council of Norway is greatly
appreciated.
1
1 Introduction
The economic literature on tax havens and financial offshore jurisdictions is
divided in its view on the effects such jurisdictions have on the global economy.
Recently a string of papers have taken a positive view on tax havens arguing that
tax havens play a beneficial role in the global economy by remedying local
externalities or restrictions on national policy. Common for these papers is that
they start from the presumption that tax havens are low-tax jurisdictions that
provide investors with opportunities for tax avoidance. In contrast, the negative
view on tax havens, which has recently been formalized by Slemrod and Wilson
(2009), assumes that tax havens sell protection from national taxation. The
activities of tax havens are therefore costly, since countries must expend
resources on enforcement, and firms must spend resources on concealing tax
evasion. This branch sees tax havens as harmful and argues that their activities
should be curbed.
In this paper I argue that the economic literature by limiting itself to the issues of
tax evasion and tax avoidance neglects to take proper account of the implications
of the business model of tax havens. Therefore, the literature fails to identify
many of the most significant externalities that follow from tax haven legislation. I
shall also show that the issue of tax havens and financial offshore jurisdictions is
not merely an economic question; it is also an ethical one. Most countries’
legislation puts aside economic arguments when issues such as drug trade,
human trafficking, or murder are on the table. In the case of tax havens, however,
the system of international law turns a blind eye to the side effects, treating only
the end outcome they produce in terms of tax evasion. In this paper I show that
tax havens provide incentives that promote activities linked to the darkest sides
of society.
My main point is that a number of tiny jurisdictions offer tailor-made company
registration schemes to facilitate tax evasion and tax avoidance. They also cater
for legal structures that allow firms to evade national and international
directives in a wide range of areas from the environment to safety and financial
regulation. Other services they provide are passports (diplomatic or regular) to
citizens who already have a genuine citizenship in another state, car and ship
registration, banking licenses, internet domains, country codes and phone
numbers. Some of these jurisdictions even allow the use of other countries’
company suffixes in order to conceal the true identity and location of the user.
The legislation that follows these services lowers the cost of all sorts of criminal
activity and - by doing so – subsidizes criminal activities that go on in other
states.
2
In essence, then, I argue that some jurisdictions sell attributes of sovereignty as a
commodity to individuals uses these attributes to conduct activities in other
states. These attributes are combined with legislation that may be used to
conceal the true identity of the purchaser or the beneficial owner. The ability to
remain anonymous means that those who purchase these services do not have to
pay the cost of any wrongdoing they undertake. The implication is that they to a
lesser extent internalize externalities that follow from their activities. I shall
argue that the sum of these incentives has a substantial negative effect on the
global community.
I also show that tax havens have a profound negative effect on poor countries to
the extent that secrecy jurisdictions can be a major hindrance to prosperity and
growth. Since tax havens provide opportunities for tax evasion and tax
avoidance, capital becomes more tax sensitive. Developing countries depend on
capital income as their main source of tax revenue, since their level of
industrialization has not reached a stage where they can build wage registries
and tax wage income. Since there are few alternative tax bases, tax havens may
lead to a rolling back of state activity that is already below the critical level of
providing primary services to its population. 2 I present arguments which show
that the reduction in public revenue that may follow from tax havens may lead to
a fall in both private and public income. Since tax havens make unproductive
activity more attractive, fewer resources are engaged in productive activity. This
may lead to a vicious circle where the end outcome is less income for all parties.
In developing countries competence is low in the public bureaucracy, corruption
is often rampant, and institutions as well as democracy are weak. In such a
setting, tax havens provide an economic opportunity to enrich oneself that goes
far beyond what is the case in developed economies. I present evidence that
secrecy jurisdictions provide incentives to the ruling elite in poor countries to
steal from society, and, that such theft harms state institutions that are vital for
economic growth. The income opportunities that tax havens represent also affect
the choice of occupation, and, ultimately, the allocation of talent in poor
countries.
Based on the evidence to the statements above I shall argue that just like harmful
trade practices, which are regulated by the WTO, the international community
should regulate legal structures that are directed at activities that take place in
other countries and that cause harm there. I offer some viewpoints on this given
the disappointing track record of the UN and OECD in creating political trust at a
global level in economic matters.
2
Tax revenue in low-income countries averaged about 13 percent of GDP in 2000 or less than half of the
average of 36 percent for the OECD countries (Baunsgard and Keen (2005) and OECD (2007)). IMF (2005)
states that tax revenue of 15 percent of GDP is a minimum requirement for sustaining basic state functions.
3
The layout of this paper is as follows. In Section 2, I offer a brief description of
related literature, whilst Section 3 discusses the business model of tax havens.
Section 4 presents evidence of how tax havens are instrumental in providing
incentives for evasion of national and international regulation. I study how tax
havens affect poor countries in Section 5, and discuss the benefit of information
exchange treaties in section 6. Section 7 offers some concluding remarks.
2 The economic literature
The economic literature on tax havens has mainly been focusing on the effects of
tax evasion and tax planning. Much of this literature has been surveyed by Hines
(2010) and Dharmapala (2008), and my survey of the literature will therefore be
brief and related to some main points.
The papers that belong to the so called positive view argue that tax havens help
overcome inefficiencies in domestic policies in high-tax countries so that in the
end tax havens benefit high-tax countries. 3 This literature assumes that tax
havens facilitate tax planning activities that help overcome inefficient domestic
policies. 4 Such policies may, for example, be that countries cannot set tax rates
on capital that discriminate between mobile and immobile capital. Hong and
Smart (2010), Johannesen (2010) and Peralta et al (2006) are examples of this
approach. Since it is well known from the standard tax competition model that a
tax on mobile capital will be shifted on to immobile factors, it is better not to tax
mobile capital. In these models tax havens allow a country to overcome its suboptimal tax policy. In Hong and Smart (2010), for example, a high-tax country
can gain from tax planning by using a tax haven, because it allows the high-tax
country to tax domestic investors without driving mobile capital away.
Related to the positive view is also Desai et al (2006a) who set up a model where
multinational firms can invest physical capital in both tax havens and non-haven
countries. They assume that investments in a tax haven augment profit income in
a non-haven. By investing in a tax haven, the costs of investments in non-haven
countries, therefore, fall. This triggers more investments into non-haven
countries and means that tax havens do not necessarily divert economic activity
from other countries. The assumption that investments in a tax haven augment
profit income in a non-haven could, for example, be due to tax planning activities.
Recent papers that according to Dharmapala (2008) is part of this emerging positive view on tax havens
are Desai et al (2006a, 2006b), Hines (2005, 2006). Other recent papers that either view tax havens as
beneficial or uses them in their analysis to obtain a favorable outcome are Dharmapala and Hines (2006),
Peralta et al (2006), Rose and Spiegel (2007), Becker and Fuest (2007), and Hines (2010).
4 One could argue that as long as countries spend substantial resources on combating tax havens this
suggests that they are not beneficial. In the case against the Norwegian shipping tycoon Anders Jahre, the
Norwegian tax authorities have over a long period of time spent more than 500 million USD in lawyer fees.
The 2010 currency value is probably closer to 1 billion USD than 500 million USD. See NOU (2009), page 27.
3
4
However, the assumption that multinationals can invest in a tax haven and at the
same time use the favorable foreign investor regime is at odds with the ringfenced legislation in these jurisdictions. Nevertheless, the results in Desai et al
(2006a) would still hold as long as one country is a low tax country and
investments in the low taxed country augment profit income in high tax
countries. 5
The negative view on tax havens sees them as harmful. The main argument, as
put forward by Slemrod and Wilson (2009), is that secrecy jurisdictions lead to
wasteful use of resources, and that they also erode the tax base of high-tax
countries. They base this argument on a model where labor and capital can
evade taxation, and where taxpayers can buy protection from national taxation
by using tax havens. In such a setting it is optimal to levy a source tax on capital
and the full or partial elimination of tax havens would improve welfare in nonhaven countries. There is a large literature that verbally describes some of the
same mechanisms as in Slemrod and Wilson (2009), but to my knowledge no
models exist that bring up other dimensions than the tax dimension in the
literature.
To sum up, then, the economic literature has mainly been studying tax havens
from the perspective of tax evasion and tax planning. In what follows, I shall
show that there are other externalities pertaining to tax havens that may have
much larger consequences for the global community than avoiding and evading
taxation.
3 The business model
There are no generally accepted criteria for determining what a tax haven is; yet
the term “tax haven” is a well known and frequently used expression. It is also
often used synonymously with or as an alternative to “offshore financial centre”
(OFC) and “secrecy jurisdiction”, but neither of these terms has a generally
accepted definition. 6 In the continuation I shall mainly use the term secrecy tax
haven instead of tax haven although the two terms are at times used
interchangeably. I prefer the term secrecy tax haven to the term tax haven
because at the heart of the business model of these jurisdictions is the combined
use of secrecy, and a ring-fenced tax system with nil or nominal taxes on capital
Desai et al (2006b) use foreign economic growth rates as instruments for firm-level growth of foreign
investments outside tax havens. They show that large U.S. multinationals and especially those with
extensive intra-firm trade and high R&D intensities are the most likely candidates to use tax havens. They
find evidence that the primary purpose of the use of affiliates in larger tax haven countries is to relocate
income away from high-tax countries, whilst affiliates in smaller tax havens are mostly used to facilitate
deferral of U.S. taxation of foreign income.
6 Several non-governmental organizations, however, define tax havens and even provide lists of countries
classified as tax havens. One example is Tax Justice Network.
5
5
income and wealth. It is these two features that make them so attractive. Many
countries may be labeled low tax countries in the sense that they offer low or
zero taxes on certain income categories, but they do not combine their low level
of taxation with a ring-fenced tax system or secrecy.
In the economic literature, there are few definitions of what a tax haven really is.
One notable exception is Hines and Rice (1994). They define a tax haven by four
attributes: “(1) low corporate or personal tax rates; (2) legislation that supports
banking and business secrecy; (3) advanced communication facilities; and (4)
self-promotion as an offshore financial center. 7
In contrast, the U.S. Government Accountability Office (BEA, 2008) in its 2008
report on the use of secrecy jurisdictions by American corporations, regards the
following characteristics as indicative of a tax haven: (1) nil or nominal taxes; (2)
lack of effective exchange of tax information with foreign tax authorities; (3) lack
of transparency in the operation of legislative, legal or administrative provisions;
(4) No requirement for a substantive local presence; and (5) Self-promotion as
an offshore financial center.
A main difference between the U.S. Government Accountability Office and Hines
and Rice (1994) is that the U.S. report specifies that secrecy jurisdictions do not
require a local substantive presence. This requirement is similar to the 1998
OECD definition of a tax haven. They used four key factors: (1) No or only
nominal taxes; (2) Lack of transparency; (3) The existence of laws or
administrative practices that prevent the effective information for tax purposes
with other governments on taxpayers benefitting from no or nominal taxes; (4)
Whether there is an absence of a requirement that the activity be substantial.
In 2001, the OECD’s Committee on Fiscal Affairs agreed after pressure from
several prominent member countries to remove the no substantial activities
criterion. Furthermore, the new initiative was to force tax transparency.
Consequently, in order to avoid being listed as an uncooperative tax haven,
jurisdictions that met criteria 1-3, were asked to make commitments to
implement principles of transparency and exchange of information for tax
purposes. As of 2010, no jurisdictions are listed as tax havens since all countries
formerly listed as secrecy jurisdictions have signaled their intent to implement
transparency and exchange of information in tax matters.
7Desai,
Foley and Hines (2006) use an intersection of criteria from Hines and Rice (1994) and Diamond and
Diamond (2002) to define a list of tax havens. Diamond and Diamond (2002) examine tax havens in more
than 70 areas around the world and rate each on the basis of 30 vital features.
6
The no substantial activities criterion was included in the OECD 1998 report as a
criterion for identifying tax havens due to the fact that the lack of local activity
suggested that a jurisdiction was attempting to attract investment and
transactions that were purely tax driven. The no substantial activity criterion is
important because in most OECD countries, a company is subject to tax at home
if it has its activity at home and/or is managed from home. Most tax havens,
however, forbid firms to invest locally if they use the favorable part of the tax
system (often named the “foreign investor regime”). For a firm registered in a
secrecy tax haven to be a tax subject there, it often comes down to whether it can
be seen as managed from the tax haven.
As a consequence, secrecy jurisdictions often demand that registered companies
appoint local nominees as board members and directors so that it appears as if
the firm is managed from the tax haven. This system is so widespread that
nominees often pose as directors and board members for hundreds and even
thousands of companies at the same time. 8 Recently, there has been a move,
especially among large multinational enterprises, to set up shell companies in
order to provide a minimum degree of physical presence. 9 One example of this is
the drilling company Seadrill. It has set up a company in the island of Svalbard,
which is a low tax jurisdiction. The Svalbard Company has a single employee
whose job it is to send a single invoice every month for the hire of two oilrigs.
The parent company saves approximately USD 14.3 million annually on this
arrangement, and pays the employee USD 86,800 per year (Endresen, 2010).
My own definition of a secrecy tax haven is a jurisdiction that fulfills most of the
following characteristics; (1) a ring-fenced tax system; (2) nil or very low
corporate and capital taxes; (3) Legislation that supports banking and business
secrecy; (4) Lack of effective exchange of tax information with foreign tax
authorities; (5) No effective regulation or supervision in a wide range of fields;
(6) An absence of a requirement that the activity be substantial.
The legal system in a secrecy tax haven is a product that is sold to non-residents
enabling them to evade and avoid taxation and regulation at lower costs than
otherwise, and it also lowers the cost of all sorts of crime. Thus, tax havens earn
their money from selling various services to non-residents, and the amount of
business they draw is so large that, even if they wanted to, most of them would
encounter severe difficulties due to their smallness in attempting to set up a tax
and regulatory system that could handle the capital that flows through them.
Since secrecy jurisdictions compete amongst themselves over customers, they
often specialize in certain areas, and their legislation often reflects their
8
See NOU (2009), page 87.
A shell company is a company that serves as a vehicle for business transactions without itself having any
significant assets or operations in the jurisdiction where it is registered.
9
7
customer base. This is why it is very difficult to make a definition where all six
points above fit. However a common and essential trait of theses jurisdictions is
the use of secrecy in banking and business combined with favorable rules
towards non-residents/foreigners. In what follows, I provide examples that
make clear the extent of specialization and ring-fencing in tax havens.
3.1 Specialization
One example of specialization is to lease out country codes and phone numbers
to individuals and businesses in other countries. This business has taken on large
proportions in some jurisdictions. Citizens of the Dutch Antilles, for instance,
spend an average of three months per year per person on international phone
calls although the majority of these calls never start in the Dutch Antilles; they
are merely rerouted through by switching mechanisms (Stølsvik, 2007). The
international phone system was meant to provide real country identification, and
non-haven countries abide by the intent of the system, but the new technology
has made it possible to escape identification and lease out numbers and country
codes. A side effect of this is the case of phone sex customers in non-haven
countries who have received enormous phone bills and found it very difficult to
make complaints.
Other jurisdictions have signed tax treaties that make them very profitable as
investment points for foreign direct investments. Mauritius, for example, has
signed a very favorable tax treaty with India that makes it attractive to use
Mauritius as a base for foreign direct investments (FDIs) in India. As a result,
Mauritius is India’s biggest investor, making up a whopping 44 % of India’s FDI
in 2009. This number is particularly interesting when one takes into account the
fact that tiny Mauritius has approximately 1 million inhabitants, whilst India
with its 1.8 billion inhabitants contains 17.3 % of the world's population. As will
become clear later, this tax treaty has interesting implications for the design of
the tax system in Mauritius.
3.2 Ring-fencing
Tax havens have recently come into the public eye due to the financial crisis, and
window dressing has therefore become an important part of their business
model. In order not to be labeled a zero or low tax jurisdiction, they have
corporate tax rates in the 10-20% interval that seemingly apply both to the local
tax regime and to the foreign investor regime. The reality is very different. An
example of this is Mauritius. 10
10 Whar follows is based on NOU (2009). Parts of the tax regime in Mauritius may have changed
since then, but the company structures described still exists in 2011.
8
In Mauritius, neither residents nor non-residents pay capital gains tax,
inheritance or wealth tax. In order to attract foreign investors, Mauritius offers
two types of companies that are only accessible to non-residents and where
secrecy applies. These companies, which are named Global Business Company 1
and 2 (henceforth GBC1 and GBC2), cannot use local currency. The restrictions
that apply mean that although they are incorporated in Mauritius, they must
conduct their business in other states. In order to add substance to GBC1
companies, they must use locals for company registration purposes, and they are
often managed by management companies.
The corporate tax rate in Mauritius is 15% and applies to both domestic (local)
companies and GBC1 companies. GBC2 companies, however, are exempted from
taxation. For GBC1 companies foreign investors can claim an automatic foreign
tax credit which yields an 80 percent reduction in the 15% rate irrespective of
whether foreign taxes have been incurred or not. This means that the nominal
tax rate is 3 percent for GBC1 companies. This should be contrasted to nonhaven countries, where tax credits are only given based on documented source
taxes falling on repatriated income. GBC1 companies, however, can also claim an
actual tax credit for taxes paid abroad, and will use whatever rule is most
favorable.
There are a number of exemptions given to both GBC1 and GBC2 companies that
make them even more favorable than what the difference in tax rates between
them and local companies signifies. Here I shall limit myself to mention that
GBC1 companies are exempted from using the designation “Limited” for
companies with limited liability, and are allowed to use company abbreviations
used in other states such as AS, OY, GmbH, and so forth. This is quite helpful if
one wants to disguise a company’s true identity. Another advantage with GBC1
companies is that they can use the tax treaties Mauritius has signed with other
countries. GBC1 Companies are therefore excellent vehicles for tax avoidance
schemes.
GBC2 companies face a zero tax rate, and can be set up in the space of 24 hours.
They are under no obligation to pay in share capital in cash, use local nominees,
and are also exempted from accounting obligations and the duty to preserve
important corporate documents. 11 As stated in NOU (2009): “The sum total of all
the liberal provisions applied to this type of company makes it very difficult, even
after a request for access, to obtain any information and ,… GBC2 type companies
are very suitable hiding places for money and other types of tax evasion.”
11 See NOU (2009), page 86.
9
Mauritius also allows so called protected cell companies (PCC), which can only
be used by non-residents. Such companies can divide their assets and liabilities
into different cells, each of which has its own name and represents a single asset
(or asset class). The total number of cells thereby comprises the whole company.
This structure provides very good protection against third parties who want to
seize assets. Mauritius derives income from the registration of each cell in such
companies. PCC companies face the same tax regime as GBC1 companies. It
should be noted that a PCC company which invests in a tax-favored object
abroad, can credit taxes paid abroad as if the investment were made in a nonfavored object by calculating what the tax would have been for such an object.
Not only does this way of applying a tax credit differ from the practice in nonhavens, but favorable arrangements of this type mean that in practice the tax
burden is probably zero for PCCs and GBC1 companies.
It should be clear from the description above that the tax system of Mauritius is
ring-fenced and with a substantial favorable bias directed at non-residents. It is
also clear from the difference in legislation pertaining to the different types of
companies that they serve different purposes. Otherwise there would have been
just one single company form.
There is no reason to believe that Mauritius is worse or better than the long list
of other jurisdictions that were previously on the secrecy tax haven list of the
OECD. But the fact that this type of legislation existed in 2009 is a telling tale that
tax havens are very much alive even after the financial crisis and despite all the
talk about ending secrecy and harmful legislative practices among G20 countries.
4 Evasion of national and international regulation
By offering anonymity to a wide range of services, secrecy jurisdictions provide
the means to avoid detection and penalties for wrongdoing, and they combine
this with the lack of regulation and/or effective supervision. This has dire
consequences for both national and international regulation in fields such as
resource management, food and transport safety, environmental standards and
human rights. Below I provide examples of such evasion from various industries.
4.1 Illegal, Unreported and Unregulated (IUU) Fishing
A number of scientific studies have shown a very significant decline in important
fish stocks around the world and have pointed out that a major reason for this is
excessive fishing, of which a substantial part is illegal fishing. 12 It is widely
acknowledged that ship registration in states that offer flags of convenience,
12
See Eriksson et al. (2009).
10
particularly secrecy jurisdictions, is integral to the problem of illegal, unreported
and unregulated fishing (OECD, 2004). 13
Secrecy jurisdictions run so called open registries, which means that they let
foreign vessels pay to sail under their flag. Registration is easily done on the
Internet for a few hundred dollars, enabling vessels to ‘re-flag’ at will. 14 Vessels
that sail under a flag of convenience in general do not have to pay for fishing
licenses, vessel monitoring systems, or abide by national or international
regulation and rules meant to preserve fish stocks, safety, worker conditions, or
the environment. And, in addition, when registered in a secrecy tax haven, these
low cost advantages are combined with owner anonymity, especially if the vessel
is owned by a company - making it possible to violate national and international
rules without facing the full consequences. 15
IUU fishing is undertaken on a large scale and is therefore a major problem.
Recent reports assess the worldwide value of IUU catches at USD 10 – 23.5
billion a year. 16 In perspective, this make up between 13-31% of global catches.
On behalf of a number of countries, Ben Bradshaw, former Minister for Local
Environment, Marine and Environmental Welfare in the UK, provided the
following widely held perspective on IUU fishing: “IUU fishing does not respect
national boundaries. It puts unsustainable pressure on fish stocks, marine wildlife
and habitats, undermines labor standards and distorts markets. It imposes
significant economic costs on some of the poorest countries in the world and
undermines governance structures.” 17
The implication of secrecy in flags of convenience states in the fishing industry is
that it is almost impossible to obtain even basic information on fishing vessel
identification, ownership, control and activity. The lack of control is serious
because the decline of fish stocks together with growing demand for fish has led
governments and governmental organizations to impose tougher regulations to
13 Illegal fishing takes place where ships operate in violation of the fishery laws. Unreported fishing is
fishing that is unreported or misreported to the relevant authority in contravention of applicable laws and
regulations. Unregulated fishing is fishing carried out by vessels without nationality, or vessels flying the
flag of a state that is not party to the regional organization governing the particular fishing areas or fishing
for fish stocks where there are no conservation and management measures in place.
14 A point in case is given by the Norwegian coast guard which on 29 June 2006 boarded a ship marked with
the name ‘Joana’ that flew the flag of the state of Sao Tome. The Norwegian coast guard, however, possessed
information that the vessel had changed flags from the state of Togo to the state of Guinea before sailing in
to Alveiro in Portugal on Saturday 14 January 2006. After sailing from Alveiro, the vessel had changed back
to the flag of the state of Togo on May 15, and later, when in international waters, changed from Togo to the
flag of the state of Sao Tome on 22 May 2006. At the last of these changes, the vessel also changed its name
from ‘Kabou’ to ‘Joana’ (NOU 2009: 19, page 38).
15 EJF (2010) lists some flags of convenience states that facilitate owner anonymity. These are; Antigua and
Barbuda, Barbados, Bahamas, Belize, Bermuda, Bolivia, Cayman Islands , Cyprus, Dominica, Gibraltar, Hong
Kong, Honduras, Isle of Man, Jamaica, Liberia, Malta, Marshall Islands (USA), Mauritius, Panama, Seychelles,
Singapore, Sri Lanka, St. Vincent and the Grenadines, Tonga, Vanuatu.
16 FAO (2010), EJF (2010), and High Sea Task Force (2006).
17 Page 7, High Seas Task Force (2006).
11
preserve stocks and ensure food security. However, tougher controls have made
it even more profitable to use flags of convenience. It has also caused fishing
fleets to seek new fishing grounds primarily along the coasts of poor countries,
Africa being one such place. Poor countries have weak fisheries governance and
the end result is often that illegal fishing undermines the conditions for local
fisheries and food security, thereby threatening the livelihoods of poor coastal
populations. 18
The International Labor Organization (ILO) has estimated that there is an
average of 24,000 deaths and 24 million non-fatal accidents in the fishing
industry annually (ILO, 2000). 19 It is reasonable to assume that fatalities and
non-fatalities in the IUU fishing fleet largely go unreported, and that the number
of deaths and injuries in IUU fishing is likely to be much higher than simply
taking the estimated share of IUU catches as a proxy. The term ‘floating coffin’
has been used to reflect the poor condition of many IUU vessels, some of which
have been allowed to deteriorate to the point of not being seaworthy with no life
rafts, flares, radio or radar. 20 It is the lack of standards and supervision
combined with anonymity in secrecy jurisdictions that is instrumental in
fostering such hazardous conditions.
Secrecy jurisdictions also provide an easy passage for criminals backing IUU
fishing. One of the darker sides of this is the abuse of human rights. IUU fishing
vessels draft workers on contracts that are described as being grossly unfair
(OECD, 2004). They also employ migrant workers or political refugees, whose
status prevents them from exercising any rights.
IUU fishing, which is well known for human abuse and fishing along the coastal
line of some of the poorest countries in the world, is especially brutal. In 2009
the United Nations’ Inter-Agency Project on Human Trafficking interviewed 49
Cambodian workers who had served aboard a so called IUU ‘slave ship’. 18% of
these were children when recruited, and they reported a number of horrendous
abuses by the captain and senior crew members. 59% of them, for example, had
witnessed the captain murder a crew member, and one 19 year old crewmember
witnessed two separate incidents of decapitation by the captain (UNIAP, 2009).
There are numerous other reports in the IUU fishing industry of murder and
slavery where those responsible for the ships cannot be traced due to the use of
secrecy jurisdictions. Perhaps the most horrifying account of them all is the
death of 39 Burmese fishermen who died of starvation due to lack of provisions
18
For a discussion on this topic see Swedish FAO Committee (2009).
According to the International Labor Organization (ILO), the number of deaths and non-fatal accidents in
the fishing industry is underreported, see ILO (2000).
20 See Gianni and Simpson (2005).
19
12
because the captain did not want to approach shore for fear of being arrested for
IUU fishing. 21
The use of secrecy jurisdictions by IUU fishing vessels is illustrative of the full
range of damages these jurisdictions create. IIU fishing vessels harm the
environment, negatively affect food security, violate national and international
governance structures, endanger species, break safety regulations, evade
taxation, and are in violation of basic human rights. These vessels and their
owners also commit crimes such as violence with murder in some cases as the
end outcome.
4.2 Safety in transport
As pointed out by Sharman (2010), the use of anonymous corporations
registered in secrecy jurisdictions has been documented in a large number of
reports related to everything from organized crime, terrorism, money
laundering, and corruption. And, as Sharman has documented, it is still possible
to register activities in various jurisdictions without the “know your customer
requirement” being enforced.
Anonymous corporations allow wrongdoers to evade regulation and to escape
responsibility. Since most people travel quite frequently by plane or by boat, and
accidents in this type of transport are often fatal, one would think that the
ownership of such means of transportation at least would foster responsibility
by the owners. Unfortunately, secrecy jurisdictions may prevent this from
happening.
One example is the Scandinavian Star accident. On the night of 7 April 1990, a
fire broke out on the ferry Scandinavian Star, which was on its way from Oslo
(Norway) to Fredrikshavn (Denmark). The fire killed 158 people and two
persons died later as a consequence of injuries related to the fire. The
investigation of the fire showed that the ship had serious defects and that ship
security regulations had not been followed. Since the ship was registered in the
Bahamas, it has so far not been possible to establish who the real owners of the
ship are, and they can therefore not be brought to court. 22
It is not only sea transport that is affected by tax havens. In 2009 the main
business newspaper in Norway revealed that the airline company Scandinavian
Airline Systems (SAS) leased passenger planes from anonymous companies in
See the article; “Burmese Fisherman Deaths Cause Outrage”,in Japan Seaman’s Union Marine Journal 4(3),
2007.
22 See NOU (2009), page 37.
21
13
the Cayman Islands (i.e., the beneficial owner could not be established).
According to Gjernes and Kibar (2009), SAS did not lease the airplanes directly
from Cayman companies, but used a go-between company called Babcock &
Brown located outside The Cayman Islands. Gjernes and Kibar (2009) found that
the Norwegian aviation authorities had registered 383 incidents on SAS flights in
the last five years up to 2009, and 274 of these had not been investigated. Many
of these incidents pertained to the Cayman Island planes. Investigations done by
Gjernes and Kibar (2009) showed that it was not possible to establish the
identity of the beneficial owners of these planes.
The main point in relation to these two stories is twofold. First, the use of secrecy
jurisdictions makes it possible for owners to hide information about assets of
importance to public safety. Secondly, if an accident occurs and it turns out that
the owner is wholly or partly to blame, the owner will remain hidden and cannot
be charged. Consequently, the owner does not bear the full cost of negligence. In
industries such as the airline industry, where safety is a major concern, national
authorities respond to asymmetric information by setting up their own safety
regulating bodies that ensure that service and maintenance are undertaken
according to high standards. However, the main point remains: asymmetric
information gives owners weaker incentives for care and maintenance than if
their identities were visible.
4.3 Sex, lies and passports
The rapid development in telecommunications has given rise to increased
business opportunities for secrecy jurisdictions. It is now possible to set up a
shell company in a secrecy tax haven, but do the actual work in another country
as long as the work involved uses computers and the internet. 23 And since some
secrecy jurisdictions allow the use of other countries’ company suffixes (such as
GmbH, Ltd, AS etc.) customers may think they are dealing with a local firm or a
subsidiary of a local firm. By the use of switching mechanisms and servers in
secrecy jurisdictions, one can send reports to customers where the files are
rerouted so that they appear to the taxman as originating in the secrecy
jurisdiction. This enables businesses to work in the country where they reside,
but collect revenue in companies registered in secrecy jurisdictions. For those
who want to take full advantage of this, they can even charge costs to a local firm
(say the parent firm) although these costs should be allocated to the secrecy
jurisdiction firm. If such working methods catch on, it poses a real challenge for
tax systems.
23 According to Slemrod (2008), the Pacific island nation of Tuvalu sold the rights to use its Internet domain
name; a deal that brings in about 15 percent of its GDP annually.
14
Another type of business that uses servers located in secrecy jurisdictions is
online gambling. A substantial part of this business is conducted from the
Channel Islands and Malta, where they use servers that handle the betting. An
interesting question is whether the risk management of these companies is
actually taking place in these locations. The answer to this question has
consequences for where they should be paying tax. Currently, they are taxed
where their servers are located (i.e. in Malta or the Channel Islands).
The international community has set up a system for identifying international
phone calls by giving each country a distinct country code. The international
phone settlement system ensures that the country in which an international
phone call originates and the one in which it is received, share the revenue from
the call. Many tiny jurisdictions such as Guyana, Niue and Tuvalu, have leased out
country codes and phone numbers in bulk to companies engaged in online sex. 24
A customer, who calls a sex worker, is not connected to someone in Niue, but the
call is rerouted through Niue to the sex worker, who may be located in the same
country as the customer. This type of set up allows these tiny countries to derive
large sums of revenue and it also allows online sex companies that want to evade
taxation to set up shell companies where parts of the customer payment are
siphoned off. The work is done elsewhere and should be taxed there as well.
Secrecy jurisdictions also offer passports to citizens of other states who already
hold a passport in the jurisdiction in which they reside. The Marshall Islands, for
example, have used sales agents to sell its passports. U.S. investigators, who
looked into the case of the Washington sniper John Allen Williams Muhammed,
found that he had bought an Antigua and Barbuda passport, which he used to
enter the U.S. 25 It is quite obvious that offering this type of service to nonnationals undermines national security in other countries and enables
individuals to change their identity at will. This has implications in a wide variety
of fields. The most damaging aspect of this – which is a recurring theme in this
article – is that such services mean that the user can disguise his true identity
and therefore does not need to internalize the full set of costs related to his own
actions.
4.4 Financial stability, regulation, and asset management
Jurisdictions that specialize in opacity have a legal system that secures
anonymity in financial transactions and allows the creation of shell companies
whose owners remain largely unknown. These legal structures create
According to Slemrod (2008) and Stølsvik (2007), Niue which is a New Zealand protectorate, is reputed to
derive approximately 20% of its government revenue from leasing out phone numbers and country codes.
25 See Stølsvik (2007). The Washington sniper attacks took place during three weeks in October 2002 in
Washington D.C., Maryland and Virginia. Ten people were killed and three others critically injured.
24
15
information asymmetries, and it is well known from economic theory that
information asymmetry weakens the market mechanism and introduces costs in
various forms.
One such cost is related to regulatory arbitrage. It is widely acknowledged that
the current financial crisis to a large degree was caused by too much risk taking
made possible by excessive debt. Despite legislation such as the Basel Accords,
where the primary aim is to ensure that banks maintain adequate capital ratios,
financial institutions were able to circumvent such rules. Debt or potential debt
obligations were kept off the balance sheets through the use of structured
investment vehicles (SIVs) or Special Purpose Entities (SPEs), so called conduit
entities. Such conduits could be kept off the balance sheets due to lax auditing
and accounting rules and many were registered in secrecy jurisdictions. 26
Arguably, problems related to SIVs or SPEs when the financial crisis hit, were
due to their off-balance sheet status causing information failure and not to the
fact that they were located in secrecy jurisdictions. However, one reason why
they were registered in secrecy jurisdictions was that it made it more difficult to
determine the extent of the risk taken and who were involved. The response to
such uncertainty in financial markets is often to increase risk premiums and thus
market transaction costs. 27
One worrisome aspect of the financial crisis is that we do not really know how
many SPEs and other entities are kept in secrecy jurisdictions. Furthermore, the
mere fact that secrecy jurisdictions exist, means that there will always be the
nagging doubt in the market as to whether all the cards are on the table. It is also
clear that the financial institutions that used these techniques and hid their
obligations gained an unjust competitive advantage. By dodging regulation they
obtained access to more credit and they avoided regulatory capital charges. This
advantage in turn contributed to excessive risk taking.
Another area where secrecy jurisdictions impede market efficiency is the stock
market. There are quite a number of court cases in various countries, where
insiders have used corporate structures in secrecy jurisdictions to disguise their
true identity in order to buy shares illegally. 28 Using a string of corporate
structures in combination with nominee arrangements has made it almost
impossible for nominees to detect that the real purchaser is red flagged.
26
See the Turner review (2009), BIS (2009), NOA (2008), and NOU (2009).
The Northern Rock (NR) bankruptcy is an interesting and illustrating case. NR was a building society
which in 2007 became a bank and the fifth largest lender in the U.K. It established a charitable Trust called
Granite which – as it turned out - did not do charity but stood for NR’s financial engineering. Investigation of
the trust also revealed that it did not have any employees despite naming some of its trustees in Jersey.
Granite had, however, a debt of 50 million pounds. See Palan (2007),
28 An example is the Norwegian state versus Nagell-Erichsen (case number 03-01353 M/02; Borgarting
Lagmannsrett).
27
16
It is also interesting to note that it is not uncommon for asset management firms
to use secrecy jurisdictions. Asset management funds very often conduct their
investments from a secrecy jurisdiction although the tactical allocation decisions
are made in another country. In other words, the work and the related costs are
allocated to a high tax country, whilst the income of the investment decisions
accrues in a zero-taxed secrecy jurisdiction. As long as these structures can
justify their actions by claiming that the investment vehicle or fund is registered
in and managed from a tax haven, they are granted tax residency. However,
anyone who has worked with international finance knows that this type of work
involves a continuous screening and rebalancing of portfolios from teams that
work below the board level. These teams are delegated authority by a board to
act within certain parameters. But this means that those who do the actual work
very often reside and create value in non-haven countries. In such cases a
management firm located in the city of London, say, may continuously adjust the
portfolio of an investment fund. This poses the interesting question of whether
these funds’ tax status is justified.
5 Tax havens and developing countries
Developing countries derive their tax revenue mainly from capital taxation, since
they do not have a well-developed registration system for wages. In Bangladesh,
for example, less than one percent of the population is registered as tax payers,
and only four percent of these contribute to 40 percent of labor taxes (Sarker
and Kitmura, 2006). The reliance of capital income is very visible in some
countries. In Tanzania, a country with over 35 million inhabitants, 286
companies contribute to 70 percent of total tax revenue (Fjeldstad and More,
2008). Developing countries have a narrower tax base than rich countries and
are for this reason more vulnerable to the incentives of tax evasion and tax
avoidance that tax havens provide. Therefore, tax havens contribute to a
narrowing of the tax base which increases the excess burden of taxation.
5.1 Multinationals
Multinationals pose a real challenge to poor countries since they are engaged in
various strategies of tax planning and tax evasion. Since the competence level in
public bureaucracy is much lower in poor countries than in rich countries,
multinationals have considerable discretion in shifting income to secrecy tax
haven affiliates. One way that multinationals can do this is by structuring its debt
so that a secrecy tax haven affiliate lends capital to an affiliate in a poor country
with high taxes. In this way the tax savings that arise from the interest
deductions in the high-tax country exceed the corresponding tax payments (if
17
any at all) in the tax haven. By excessively stacking debt in poor countries where
thin capitalization rules are not in place and the competence level in the
bureaucracy is low, taxable income is reduced. 29
A second strategy used by multinationals is to misprice intra-firm transactions.
Most countries’ tax legislations state that the correct price between related
affiliates is the market price, that is, the price that would have occurred in the
market place between independent parties (often termed the arm’s length price).
Multinationals, however, very often transfer assets that are specialized to such
an extent that comparable products do not exist in the market place, or the
products transferred are intangible in nature (e.g. patents, technical knowledge,
or the use of specialized consultants). This means that multinationals have
considerable discretion in setting their transfer price. There is evidence in
support of such mispricing strategies in developing countries where income is
shifted to tax havens (see Fuest and Riedel, 2010). However, the lack of good
data often makes studies on developing countries more difficult to undertake
than what is the case for rich countries. 30
There is also ample evidence suggesting that multinationals are able to negotiate
contracts related to the extraction of natural resources that effectively shelter
them from taxation. Such contracts may partly be due to incompetence in the
bureaucracy in poor countries, but they may also reflect deals struck by
politicians that benefit from these contracts rather than making sure they benefit
the nation they should be serving. Secrecy jurisdictions play a role even here
because they provide a hiding place for illicit money from such deals..
5.2 Institutions and tax havens
During the past decade it has become clear that institutional quality is one of the
most important drivers for economic growth. Acemoglu, Johnson and Robinson
(2001) estimate that a country located in the 25 per cent percentile for
institutional quality could increase its national income sevenfold if it were able
to improve its institutional quality sufficiently to move into the 75 per cent
percentile.
Among the most damaging aspects of secrecy jurisdictions is the fact that they
contribute to the weakening of institutional quality and democracy in poor
countries. This is so because they enable the ruling elite in poor countries to
conceal income derived from corruption, development aid, natural resources or
See Mintz and Weichenrieder (2010) for a survey of the literature on debt shifting.
Mispricing of intra-firm transactions is documented in a number of studies, see Hines (1999)
and Gresik (2001). Fuest and Riedel (2010) survey the role of profit shifting in developing
countries.
29
30
18
the budget. Since secrecy jurisdictions offer anonymity and escape clauses, as
well as the ability to move funds between secrecy jurisdictions, they make it
more profitable to engage in such crimes. 31 And these incentives also make it
more attractive to dismantle institutions and weaken the workings and control
of the political system.
In the economic literature on tax havens, the possibility that secrecy jurisdictions
could facilitate criminal activities, including crimes by dictators, is often doubted.
Hines (2010), for example, writes: “Some worry that corporate and banking
secrecy offered by tax havens could facilitate criminal activities including crimes by
dictators, terrorist and drug-related activities.” He concludes: “These concerns are
all plausible, albeit often founded on anecdotal evidence rather than systematic
evidence.” There is, however, ample and systematic evidence showing that one
should worry. The list of presidents (and often also dictators) from poor
countries that have stolen public funds and hidden them in secrecy jurisdictions
is long. One example is that of Mobutu Sese Seko, who was president in the
Democratic republic of Congo, Zaire (DRC) from 1965 to 1997. Tax havens
helped Mobutu conceal assets and money he, as president, stole from the state
(NOU, 2009). Acemoglu, Robison and Verdier (2006) state on page 116: “There is
no doubt that the aim of Mobutu was to use the state as enrichment for himself and
his family.” The havoc Mobutu caused on the economy of DRC was so devastating
that income per capita in 1992 was half of what it was at independence.
Mobutu is not the only one. Sani Abacha, former president of Nigeria, hid three
billion USD in anonymous accounts in Switzerland. Most of this money has since
been repatriated to Nigeria after various court cases, but the investigation
against Abacha also revealed trails of money to other secrecy jurisdictions. These
funds have not been recovered. 32 Systematic evidence is presented in Gordon
(2009) who provides 20 examples of theft of state money that could have been
used to build institutions and, in NOU (2009), evidence of crimes committed by
politicians in poor countries are detailed. A common misperception in the
economic literature, therefore, is that theft by state leaders comes down to a few
single cases (or does not exist at all), but as is seen from the above, this is not the
case. Misuse of power is widespread in poor countries. President Zardari of
Pakistan is a recent example. He stopped the country’s investigation against him
when he came to power (see NOU, 2009), and Egypt’s Hosni Mubarak is the last
name on a long list of presidents in developing countries that have misused
public funds and hidden them in secrecy jurisdictions. My main point in this
section is that such crimes will not disappear, but they would be much more
An example of redomiciliation between secrecy jurisdictions is given in NOU 2009: 19, page 36.
The trial against Sani Abacha is described in various sources as well as in court case documents in
Switzerland. For a brief description of the case see Box 8.3 in NOU (2009).
31
32
19
difficult to carry out and less profitable to conduct if secrecy jurisdictions did not
exist.
Since secrecy jurisdictions provide incentives to steal from society they also
provide incentives to weaken ‘balances and checks’ that are in place to prevent
such theft. Ross (2001a) shows that the wealth represented by rainforests in the
Philippines, Indonesia and Malaysia contributed to the conscious destruction of
state institutions intended to prevent misuse and excessive exploitation. Former
president Suharto of Indonesia topped Transparency International’s 2004 list of
the world’s most corrupt leaders and is, together with his family, estimated to
have misappropriated between USD 15-35 billion, some of which islinked to
rainforest exploitation. 33
Even more worrisome is the possibility that secrecy jurisdictions may affect the
political system in poor countries. Ross (2001b) finds that, ceteris paribus,
countries with large oil deposits tend to become less democratic because
democracy carries a cost to politicians that prevents them from using
government revenue as they please. Resource rents, therefore, can give the
political elite incentives to weaken democracy. In the same vein, secrecy
jurisdictions offer income opportunities to the ruling elite in poor countries that
can lead to less democratic control of those in power. These perspectives are
worrisome especially since, as shown by Collier and Hoeffler, (2009),
institutional rules that limit the potential for political abuse of power enhance
growth. Collier and Hoeffler, (2009) find that, especially in developing countries,
rich in resources, “balances and checks” to limit the power of politicians are
undermined by politicians.
A commonly held belief among academics and policymakers has been that the
choice of political system (presidential or parliamentary) is formed by historical
choices. Robinson and Torvik (2009), however, show that this explanation is
inadequate. For example, at independence there were 27 countries south of the
Sahara. Five out of 27 were presidential, whilst the rest were parliamentary. In
2009, only three out of the 27 countries were parliamentary (Botswana,
Mauritius, and South Africa), two of which (Botswana and Mauritius) have done
much better in economic terms than the rest. An interesting question is why all
these countries have chosen a form of government that in the end has led to
worse economic outcomes.
Torsvik (2009) makes the point that the transition to presidential rule in
Southern Africa has given a narrower political elite greater political power and
has led to a less democratic system in these countries. Given the substantial
33
See NOU 2009:19 (page 60) for a short brief of the Suharto case.
20
amount of evidence showing that presidents in newly constituted presidential
regimes in Africa have abused their power and used secrecy jurisdictions to hide
stolen funds, it is clear that secrecy jurisdictions provide incentives for personal
enrichment through a political career. The very opportunity that secrecy
jurisdictions present may even have consequences for the types of people who
seek a political career. It is quite clear that even if secrecy jurisdictions did not
exists, there would still be dishonest politicians, but the presence of secrecy
jurisdictions makes matters much worse.
5.3 Tax havens and income in developing countries
In contrast to rich countries, poor developed countries have a high crime rate,
corruption is much more widespread, and the competence level and quality of
the public bureaucracy are low. In addition, the political system is often weak
and with concentration of power. In such a setting it is more attractive to engage
in activities that are destructive such as banditry, corruption, rent seeking and
tax evasion. In such a setting entrepreneurs may also find it profitable not to
engage in productive activities. Drawing on Mehlum et al (2006), occupational
choice between productive activities and unproductive activities, here called
rent-seeking, is illustrated by Figure 1.
Figure 1.
21
The solid line in Figure 1 shows (starting from the left) that the larger the
number of people who become productive entrepreneurs the higher the income
for each entrepreneur. This is so because the more people that create value, the
higher is income. High income in turn gives rise to high demand and increases
the tax base. This enables governments to provide better public infrastructure
which may enhance private productivity and thus income.
The dashed-dot-dot line in Figure 1 shows income for those who choose rent
seeking as an occupation. Starting from the right, an increase in the number of
people who engage in wasteful activities leads to lower production and income.
The reason for this is partly that as more people engage in unproductive
activities, competition among them increases and presses down income.
Furthermore, as more people move from productive activities to unproductive
activities, production falls and consequently there is less income to prey on.
In Figure 1 the equilibrium occurs when the income in rent-seeking and
entrepreneurship is given by the income point I0 and the division of the
workforce at point E0. In equilibrium nobody has an incentive to switch between
unproductive and productive activities. The equilibrium is stable in the sense
that to the left of the intersection between the two curves income is higher in
production, and people will switch to productive activities until income
opportunities are equalized. To the right of the intersection income is higher in
rent seeking, and entrepreneurs will switch to rent seeking until income in rent
seeking is equal to income in the productive sector.
How do secrecy jurisdictions influence this equilibrium? Torvik (2009) argues
that they increase the profitability of undertaking rent-seeking activities, since
secrecy jurisdictions provide a safe hiding place and because they sell technology
that can be used to reduce the cost of illegal activities. This means that the rent
seeking curve shifts upwards. This is illustrated in Figure 1 by an upward shift of
the dashed-dot-dot line. The shift upwards implies that even fewer people will be
engaged in productive activities and leads to a new equilibrium (I1, E1), where
has fallen for everyone in the economy. This follows from a multiplicative
process where the income rent seekers prey on falls when people move from
productive to unproductive activities. 34
It is not easy to assess the effect of the income opportunities that secrecy
jurisdictions give rise to, mainly because they are shrouded in secrecy. However,
34
Notice that the income curves in Figure 1 are drawn such that the income curve of the rent seeker is
steeper than that of income from entrepreneurship. As shown in Torvik (2002), if one reversed the
steepness of the curves, the economy would have two stable equilibrium points. One where no entrepreneur
would find it profitable to engage in productive activities - a poverty trap equilibrium - and one where
nobody would find it profitable to become rent seekers. Introducing the income opportunities that tax
havens give rise to in this setting would not affect the number of equilibriums.
22
it is possible to find by studying how other types of income opportunities affect
countries. Natural resources, for example, represent an income opportunity that
arises irrespective of whether a country is rich or poor. Different from the
income opportunity that arises through the use of a secrecy jurisdiction, one
could argue that the extraction of natural resources like oil and gas yields greater
benefits to society, since such activities create business related to the extraction
itself, by employing people on oilrigs and in service industries related to the
extraction itself. Income opportunities from secrecy jurisdictions, in contrast, do
often reduce public revenue and have few positive spillover effects. Therefore, if
one uses the income opportunities that arise from natural resources as a proxy
for the income effects presented by secrecy jurisdictions, one would
underestimate the possible negative effects of secrecy jurisdictions.
5.4 The resource curse
It is well known in the economic literature that countries that derive large
revenues from the extraction of natural resources have on average a lower level
of income than countries without income from such resources. 35 This
paradoxical phenomenon is often referred to as the “resource curse” or the
“paradox of the plenty”, and is relevant to the issue of secrecy jurisdictions for
two reasons. First, the income opportunities represented by natural resources
are an indirect way of estimating how the income opportunities arising from
secrecy jurisdictions affect countries. Natural resources and secrecy jurisdictions
affect both poor and rich countries, and they both represent a possibility of
higher private income. But the latter is hidden by secrecy and therefore difficult
to measure. Second, as will become clear later, secrecy jurisdictions are a natural
part of the explanations behind the resource curse.
Mehlum et al (2006 a,b) control for a whole range of factors that may explain
why resource abundance may lead to lower growth. They find that resource
abundant countries become growth winners or losers depending on the quality
of their public institutions. 36 In countries where the government does not
effectively support property rights and is unable to provide basic security, and
where corruption is widespread in the public bureaucracy, growth is low despite
resource richness. Similarly, Boschini et al (2007) study how different types of
natural resources influence growth – and how this depends on institutional
quality. They find that the decisive factor for the effect on growth is the
combination of institutional quality and the ease with which various natural
See Auty (2001) for a survey of these findings.
Sachs and Warner (1995, 1997a) show that resource abundance does not cause poor quality of
institutions.
35
36
23
resources can be seized. 37 Diamonds, therefore, are more harmful that oil since
they are more easily extracted. From these studies, then, comes the message that
in countries where institutional quality is low, it is much more profitable to
pursue rent seeking activities that harm income and growth. Since secrecy
jurisdictions provide incentives to weaken institutional quality, they are part of
the explanation for the resource curse. Not only do secrecy jurisdictions provide
incentives for the theft of state money, they also make it more difficult for poor
countries to make the best out of whatever natural resources they have.
Andersen and Aslaksen (2008) study whether the democratic system matters for
the resource curse. They show that the resource curse is relevant in democracies
with presidential rule, but not in countries with parliamentary rule. There is no
link between resource abundance and growth in countries with parliamentary
rule. It is not easy to asses why the resource curse should be closer linked to
presidential rule, except for the fact that in many developing countries, the type
of presidential rule that has come into play, yields much more concentrated
power to the president than in rich countries. This means that a wider circle of
the ruling elite depends to a much greater extent on the president, whilst the
reverse is often true in developed countries. As a result, the president in such
regimes can pursue policies that are in his interest rather than in that of the
nation. Secrecy jurisdictions will make such selfish strategies a much more
attractive proposition.
6 Information Exchange Treaties
The harm caused by secrecy jurisdictions in a wide variety of fields as well as the
tax revenue losses incurred by countries due to tax evasion and theft, especially
from poor countries, have led to a massive amount of international pressure on
secrecy jurisdictions to reform their systems. In response some of these
jurisdictions now have legislation in place regarding financial auditing, surveying
and regulation on par with the majority of the OECD countries. However, as
reported in NOU (2009), such rules are not enforced in practice. This gives rise to
the suspicion that they have enacted such rules because it is in their own interest
to appear to be cooperating internationally, not because – as in other countries –
such legislation has grown out of the need for rules and systems that balance the
interests of minority shareholders, investors and society at large. The lack of
such drivers means that the incentives to comply are weak. Adding to this is the
fact that secrecy jurisdictions most often are very small jurisdictions, and that
The studies by Mehlum, Moene and Torvik (2006a,b) and Boschini, Pettersson and Roine (2007) contrast
the popular perception that Dutch disease explains the resource curse. In doing so they point out that it is
not clear why the crowding out of the traded goods sector should affect institutional quality.
37
24
the amount of capital that is sloshed through them is formidable. The Cayman
banking system, for example, holds assets of over 500 times its GDP. Therefore,
many of the secrecy jurisdictions lack the resources in terms of people and
competence, to abide by the rules and regulations that the international society
wants them to establish. 38 And if they gave up opacity, their national income
would be harmed. This indicates that secrecy jurisdictions are not in this process
with their hearts, but rather because of international pressure.
On 2 April 2009, the G20 countries held a meeting on the financial crisis where
tax havens were one of the main topics on the agenda. The U.K. Prime Minister
Gordon Brown saw the meeting as a success, and warned individuals and
corporations investing in tax havens that their money would be unsafe: "There
will be no guarantee about the safety of funds there. If tax information is
exchanged on request, as these countries have agreed to, then the benefits from
being in these countries will diminish every day." 39
The statement by Mr. Brown was made in reference to the information exchange
initiative by the OECD, where secrecy jurisdictions in principle have agreed to
sign tax information exchange treaties (TIEAs). A positive quality of the TIEAs is
that, on request, a jurisdiction must provide information both in civil and
criminal matters. Previously, information was not provided in civil matters, and
very often not even in criminal matters. The implication was that tax evasion by
filing a false return was not considered a crime and no information would be
supplied on such accounts. Under the TIEAs, however, tax evasion information
will be provided.
Some economists and policymakers argue that it remains to be seen just how
effective the TIEAs are in practice. The reason for such doubts is that under
TIEAs, the requesting jurisdiction must provide significant accurate information
in the letter of request, to avoid allegations of "fishing expedition"; e.g. identify a
specific person, transaction, account, trust or company, linked up to the
suspicion in question, and the tax purpose for seeking the information. It must
also provide evidence for why it believes the requested jurisdiction holds the
information in question and demonstrate that it has exhausted all other means of
information (within reason). Furthermore, the requested jurisdiction does not
need to adhere to a request if the requested information pertains to information
the requested jurisdiction does not collect. 40
38
The inability of many of these jurisdictions to perform such tasks has been pointed out in NAO (2007) and
in NOU (2009).
39 Watts et al (2009).
40 See article 2 in the OECD blueprint for TIEAs. It states that a requested party is not obligated to provide
information which is neither held by its authorities nor in the possession or control of persons who are
within its territorial jurisdiction
25
As a matter of fact, most so called tax havens collect very little information. The
British Virgin Islands, for example, require neither the identification of
shareholders or directors nor the maintenance of accounts or financial
records. Furthermore, trusts and companies can be redomiciled to other tax
havens quickly and with very few formalities. The same is the case for many
other secrecy jurisdictions. Since taxes are not levied on capital income, such
records have no value to a tax haven. Therefore, requests pertaining to who are
the beneficial owners of a company, say, would in many cases not be responded
to. More worrisome is the dynamic aspect of this. If only collected information
falls under TIEAS, secrecy jurisdictions - given the "exemptions" they offer to
foreign companies - have a clear incentive to collect as little information as
possible in order to circumvent TIEAS. Paradoxically, then, TIEAs may actually
lead to less information being collected and exchanged.
From an ethical point of view one may ask why it would not suffice, say, for a
requesting country to provide evidence that a certain tax payer has evaded tax at
home, and based on this, request information about deposits, say, in another
jurisdiction. Such requests, however, are labeled “fishing expeditions”, since the
requesting jurisdiction does not have evidence that links the taxpayer to the
requested jurisdiction. Such requests will therefore be left unanswered in a
secrecy tax haven jurisdiction.
It should also be added that even among non-tax havens information TIEAs are
not working too well due to what we might call a lack of market structure. When
a country requests information from another country, it is always costly to
comply with such requests for the requested jurisdiction. And there is no
corresponding income side to the cost side other than potential goodwill that
may or may not materialize in the future. Because of this responses are slow and
sometimes insufficient, and, for obvious reasons, it is very difficult to go public
with such discontent.
Finally, TIEAs will not lead to the abolishment of the ring-fenced tax system in
tax havens nor will they eliminate harmful trust structures, protected cell
companies, or legal structures that are forbidden in most non-haven countries.
Therefore, secrecy will still thrive although the TIEAs have made it a little more
costly to use tax havens. But for those who engage in all sorts of criminal
activities, or want to hide their ownership and identity, secrecy jurisdictions
remain a very attractive proposition.
In the business sector a common phrase among CEOs is that since everybody else
is using secrecy jurisdiction they must do, too. This is like an echo from the past
26
when company leaders said that they had to use children as laborers because
everybody else did. As I started out, this is a topic where greed trumps ethics. As
with child labor, the world will not move forward unless we see some leadership
that goes beyond what the OECD is aiming for with the TIEAS.
7 The future
A hint of the way forward may be found by studying how the World Trade
Organization (WTO) came about. In the 1930s the world economy was ripe with
trade wars that hampered economic growth, prosperity and financial stability.
The Bretton Woods Conference of 1944 recognized the need for an international
institution for trade that could work side by side with the World Bank and the
International Monetary Fund. The new organization was negotiated and named
the International Trade Organization (ITO). It was to be a United Nations
specialized agency. Its charter was completed in Havana in 1948, and implied
that ITO would address not only issues related to trade and tariffs, but also
issues such as employment, investment, restrictive business practices, and
commodity agreements. The ITO charter, however, was never ratified, since a
number of signatories, among them the U.S., never approved it. 41 The main
reason for this was that ITO was seen as interfering with internal economic
matters.
In December 1945, a small group of 15 countries began talks to reduce customs
tariffs. They wanted to give an early boost to trade liberalization, and to start
correcting the legacy of protectionist measures, which remained in place from
the early 1930s. Their first round of negotiations, which ended with a deal in
October 1947 called the General Agreement on Tariffs and Trade (GATT), had
seen the group expand to 23 countries. The tariff package they agreed on
involved one fifth of the world’s trade and came into effect in 1948.
The 23 founding partner countries were also part of the larger group negotiating
the ITO Charter. However, when the ITO failed to become ratified, the GATT
became the only multilateral instrument governing international trade from
1948 until the GATT transformed itself into the WTO in 1995. 42 It is interesting
to note that it was a private initiative among a small group of countries that
eventually lead to the WTO. It was not the result of consensus. Over time,
41
Paradoxically, the U.S. was one of the driving forces behind ITO, but it turned out to be impossible to
persuade Congress to approve the Charter. On December 6, 1950, President Truman announced that he
would no longer seek Congressional approval of the ITO Charter.
42
The GATT still exists as the WTO's umbrella treaty for trade in goods, updated as a result of the
Uruguay Round negotiations.
27
countries gave their support because they realized that trade wars were
detrimental to welfare. It took the world over 50 years to recognize that trade
wars are harmful and that international rules are needed in order to create
prosperity and growth.
Capital mobility, in contrast, is a relative recent phenomenon since most
countries enforced restrictions on capital movements in the 1930s. It was only in
the late 1980s that most OECD countries liberalized their foreign exchange
regulations and by doing so created free capital mobility. Alas, the problem of tax
havens became much more pronounced. The history of the WTO tells us that
consensus agreement is hard to achieve, and that chances are better if a group of
countries negotiate and commit to non-harmful legislation and transparency, as
well as to the right to defend themselves against harmful legal structures, that is,
structures that much like tariffs are aimed directly at the well being of other
nations. The political question this begs is whether there is political momentum
for a convention on transparency and non-harmful legal structures.
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